Profit Is Not Cash
Why a profitable month can still leave the bank account short.
In your head, jot if needed · no calculator why?
Opens at level 16. You're level 1. You can read and practice here now.
the idea
Profit and cash answer different questions. Under accrual accounting, revenue counts when the work is done and expenses count when they are used up, whatever day the money moves. Cash counts only money that actually came in or went out.
So a profitable month can leave the bank account short: the customer pays next month, but this month's bills are due now. Cash can also leave with no expense, as when you repay loan principal, pay the owner a distribution, or buy equipment. Depreciation works the other way: it cuts profit, and no cash moves.
techniques
Keep two columns
- Profit column: work done this month, minus this month's expenses.
- Cash column: only money that came in or went out.
- A prepayment is cash in, but not profit until the work is done.
worked example
A plant-care service finishes a $9,000 job this month; the customer pays next month. It pays $5,000 of this month's costs now. With no other transactions, what is this month's cash change? (Use a minus sign for a decrease.)
- Profit: $9,000 − $5,000 = $4,000.
- Cash in: $0. Cash out: $5,000.
- Cash change: −$5,000.
Answer: −$5,000
Split a loan payment
- Interest is the cost of borrowing: an expense.
- The rest is principal, which shrinks the debt.
- Cash still falls by the whole payment.
worked example
Of a $900 loan payment, $120 is interest. How much of the payment reduces the loan principal?
- Principal: $900 − $120 = $780.
- Only the $120 of interest is an expense.
Answer: $780
Days of sales tied up
- Take the average credit sales per day.
- Multiply by the extra days customers take.
worked example
A tutoring service bills $400 a day, all on credit. Customers now pay 10 days later than before. Roughly how much extra cash is tied up in receivables?
- Each extra day holds back one more day of sales.
- $400 × 10 = $4,000.
Answer: $4,000
watch out for
- Giving the profit as the cash change. Profit counts work done; cash counts money received.
- Counting a customer's prepayment as this month's revenue. It is work you owe until it is done.
- Treating the whole loan payment as an expense. Only the interest is.
practice
This month's cash change
worked example
A completed job earns $4,000. Its $2,000 expense is paid now, but the customer pays next month. With no other transactions, what is this month's cash change? (Use a minus sign for a decrease.)
Answer: -$2,000.00
- Cash only moves when money moves: $0 in − $2,000 out = −$2,000.
- This month's accrual profit is still $4,000 − $2,000 = $2,000.
This month's accrual profit
worked example
This month you finish $7,500 of work (the customer pays in 30 days), a customer prepays $1,000 for work you'll do next month, the bank lends you $16,500, and you pay $2,000 of this month's expenses. What is this month's accrual profit? (Use a minus sign for a loss.)
Answer: $5,500.00
- Accrual profit counts revenue when it's earned: $7,500 earned − $2,000 of expenses = $5,500.
- The prepayment is work you owe (a liability) until next month.
- The loan is a debt, not revenue.
Interest or principal?
worked example
Of a $1,150 loan payment, $510 is interest. How much reduces the loan principal?
Answer: $640.00
- Principal = payment − interest = $1,150 − $510 = $640.
- Only the interest is an expense; the principal part just shrinks the debt. Cash still falls by the full $1,150.
Cash tied up by slower collections
worked example
Sales average $1,700 a day, all on credit. Customers now pay 15 days later than before. All else equal, how much extra cash is tied up in receivables?
Answer: $25,500.00
- Each extra day of waiting holds back one more day of sales: $1,700 × 15 = $25,500.
- It's a rough steady-state figure, not a full forecast.
Cash out, but not an expense
worked example
For a food truck, which of these reduces profit this month but uses no cash this month?
- Paying $2,000 of this month's rent
- Paying the owner a $1,000 distribution
- Recording $250 of depreciation on equipment
- Paying a $550 supplier bill that was recorded as an expense last month
Answer: Recording $250 of depreciation on equipment
- Depreciation spreads the cost of equipment bought earlier. It lowers profit now, but no cash moves.
- The other choices all use cash this month.